LCWDPA - the basis of passive investment

What is passive investing

Passive investing, in simple words, is the purchase and long-term retention of securities. An investor who adheres to this strategy seeks to maximize profits by performing as few trading activities as possible. He tries to hold shares and bonds for a long period, focusing on a well-known pattern: in the long run, the market always grows and has an overall positive return. In addition, for frequent operations with securities you have to pay a commission, so with intensive trading costs increase.

Look at the chart in the history of the American stock market:

The dynamics of the American stock market

The red and blue lines are S indices&P 500 (top 500 US companies) and Dow Jones (top 30 US companies), blue – Dow Jones corporate bond index, pink – 10-year government bonds. As you can see, stocks are much more profitable than bonds. Any 15 year gap S&P 500 and DJII on this chart are positive, and any 30-year-old has a return of at least 7.6% per year.
Passive investors create well-diversified portfolios of stocks and bonds with stable performance and use those stock market instruments that over the years would build a chart like the one mentioned above. They are not trying to make money on short-term price fluctuations. The goal of passive investing is to gradually build wealth..

Strategies for a Passive Investor

Despite a simple basic principle, there are several strategies for passive investing..

1. LCWDPA – the basis of passive investment

LCWDPA – Low-Cost, Widely Diversified, Passive Investing, i.e. low-cost, widely diversified passive investment.

This strategy calls for:

• Compose a portfolio of securities of stable companies from different industries, countries, sectors, as well as differing in market capitalization. Stable companies are those who work without loss, maintain or increase the level of net profit from year to year, do not incur debts and regularly pay dividends.

• Do not sell these assets in virtually any market environment, no matter how difficult they may seem..

• Regularly buy assets by depositing fresh money to a brokerage account or reinvesting dividends.

• Keep costs low. Perform fewer operations and monitor commissions. Every penny you save is extra money for your family..

But this approach to investing money is still not completely passive. Before buying securities, the investor must independently analyze the statements of companies, choose the appropriate ones. To diversify and then periodically monitor and review the state of the portfolio. More traditional methods of passive investment are ETFs and mutual funds..

2. Investing in ETFs

ETF (Exchange Traded Fund) – a stock exchange-traded fund. Buying ETFs, you invest in the shares of all companies in a country or industry at once. The ETF asset structure follows the structure and dynamics of the index. For example, the ETF of Russian stocks reflects the dynamics of the Moscow Exchange. If the index grew by 10%, then ETF grew by 10%. An index is an information product. It is convenient in that it demonstrates the state of the entire country’s market.

There are also ETFs that repeat the dynamics of the indices of the USA, Germany, China and other countries. What index is the foundation based on and its composition can be found in the fund’s documentation.

ETFs are the easiest and most obvious way to invest in LWCDPA. After all, it includes many companies and thereby is widely diversified. You do not need to do routine tasks: pick up paper, balance, reinvest. The foundation does all this..

But you cannot invest all your money in just one ETF. They also need to be diversified. For example, buy ETF shares of Russian companies, ETF shares of IT companies in the US sector and ETF shares of Chinese companies. So, you will cover the economies of different states and protect yourself well if one of the indices goes into decline. ETF is also good because it has a low entry threshold. One share does not exceed the cost of 5,000 rubles.

Cons rather lie in the legal field. In contrast to the purchase of shares and bonds, the investor does not even partially become the owner of the company or its debt. Several shares are available on the Moscow Exchange ETF-funds under a common brand Phinex. The funds are registered in Ireland under European law, are managed by English companies, but immigrants from Russia stand behind them..

To overtake the market and maximize profits along with ETFs also fail. This tool mirrors it. ETF also does not pay dividends.

3. Investments in mutual funds

In structure, the mutual fund (unit investment fund) is similar to the ETF. Both of them provide good diversification and do not force the investor to delve into the nuances of the market. But there are differences. A mutual fund is a company that manages the fund’s capital, which consists of investor money. The goal is to increase this capital and distribute its profits among the participants in the fund. Commissions for mutual funds are higher than for ETFs. An average of 3-4% per year for management. You can buy a unit investment fund in the office of the company or not on its website, but it may take time to sell it. ETFs are traded freely. You can buy and sell them calmly on any trading day..

Not all mutual funds display index dynamics like ETFs. A set of assets is compiled by investment professionals who work in a management company. They choose strategists and trading methods. For example, the Sberbank-Natural Resources mutual fund invests in shares of companies specializing in the extraction and processing of oil and gas. Mutual Investment Fund “VTB – Equity Fund” invests in fundamentally undervalued shares with a focus on “blue chips” – shares of the largest and most stable Russian enterprises. Buying a mutual fund share, you actually give money under professional control and accept the fund’s strategy, relieving yourself of the tasks of choosing securities and managing them.

To choose a mutual fund, study its statistics: profitability, assets and commissions. Do not limit yourself to a profitability rating for the last year. Check who is the manager of the mutual fund, read articles about this person. Entrust him with money?

Who is passive investing suitable for?

Summarizing the written, we note, what This investment approach will be convenient for people who:

• Do not want to waste time collecting and analyzing securities. Learning theory.
• Emotionally resilient. They control themselves, even during a severe market downturn.
• Do not seek to follow hot financial and investment trends.
• Do not want to overtake the market and are ready for average return on investment.

Passive investing with a long-term strategy is chosen by most “ordinary” people. Those who are 100% immersed in the market are active. But you can consider a combined option – to divide the capital between the two strategies, while maintaining good diversification.

Active investment requires a deep analysis of companies, to be aware of all the events affecting the market. Of great importance is experience, which sometimes intuitively tells where to turn around and where to put pressure on the gas.

What is passive investing

Strategies for a Passive Investor

1. LCWDPA – the basis of passive investment

2. Investing in ETFs

3. Investments in mutual funds

Who is passive investing suitable for?

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